Chapter 2: Basic Managerial Accounting Concepts.pptx

CORNERSTONES
of Managerial Accounting, 5e

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CHAPTER 2:
BASIC MANAGERIAL
ACCOUNTING CONCEPTS
Cornerstones of Managerial
Accounting, 5e

Learning Objectives
1. Explain the meaning of cost and how costs are
assigned to products and services.
2. Define the various costs of manufacturing
products and providing services as well as the
costs of selling and administration.
3. Prepare income statements for manufacturing
and service organizations.

The Meaning and Uses of Cost
Determine the cost of products, services,
customers, and other items to managers.
Cost is the amount of cash or cash equivalent
sacrificed for goods and/or services that bring a
current or future benefit to the organization.
LO-1

The Meaning and
Uses of Cost (cont.)
As costs are used up in the production of
revenues, they are said to expire. Expired costs
are called expenses.
On the income statement, expenses are
deducted from revenues to determine income
(profit).
We can look more closely at the relationship
between cost and revenue by focusing on the
units sold. The revenue per unit is called price.
LO-1

Accumulating Costs
Accumulating costs is the way that costs are
measured and recorded.
Recorded
Phone
Bill Accounts
Payable &
Telephone
Expense
Account
LO-1

Assigning Costs
Assigning costs is the way that a cost is linked to
some cost object.
What is the
cost object
for the
phone
call?
To support
Manufacturing?
To support Selling
the Product?
????
????
??
LO-1

Cost Objects
Managerial accounting systems are structured to
measure and assign costs.
A cost object is any item such as a product,
customer, department, project, geographic region
or plant, for which costs are measured and
assigned.
LO-1

Assigning Costs to Cost Objects
Costs can be assigned to cost objects in a
number of ways.
The choice of a method depends on a number of
factors, such as the need for accuracy.
The objective is to measure and assign costs as
well as possible, given management objectives.
LO-1

LO-1
For Which BusinessActivities Do We
Need an Estimate of Cost?

Direct Costs
Direct costs are costs that can be easily and
accurately traced to a cost object.
When a cost is easy to trace, we mean that the
relationship between the cost and the object can
be physically observed, is easy to track, and
results in more accurate cost assignments.
LO-1

Indirect Costs
Indirect costs are costs that cannot be easily
and accurately traced to a cost object.
Allocation means that an indirect cost is
assigned to a cost object by using a reasonable
and convenient method.
Allocating indirect costs is based on convenience.
LO-1

Object Costing
Direct and indirect costs occur in service
businesses as well.
 Some businesses refer to indirect costs as overhead
costs or support costs.
LO-1

Other Categories of Cost
Costs can be direct or indirect, and are analyzed
by their behavior patterns, or the way in which a
cost changes when the level of the output
changes.
 Variable cost: A variable cost is one that increases in
total as output increases and decreases in total as
output decreases.
LO-1

Other Categories of Cost (cont.)
 Fixed cost: A fixed cost is a cost that does not
increase in total as output increases and does not
decrease in total as output decreases.
 Opportunity cost: An opportunity cost is the
benefit given up or sacrificed when one alternative
is chosen over another.
LO-1

Product Costs
Output represents one of the most important cost
objects.
There are two types of output: products and
services.
Products are goods produced by converting raw
materials through the use of labor and indirect
manufacturing resources, such as the
manufacturing plant, land, and machinery.
 Televisions, hamburgers, automobiles, computers,
clothes, and furniture are examples of products.
LO-1

Service Costs
Services are tasks or activities performed for a
customer or an activity performed using an
organization’s products or facilities.
 Insurance coverage, medical care, dental care, funeral
care, and accounting are examples of service activities.
 Car rental, video rental, and skiing are examples of
services where the customer uses an organization’s
products or facilities.
LO-2

Service Costs (cont.)
Services differ from products in many ways.
Services are intangible
Services are perishable
Services require direct contact
between providers and buyers
1
2
3
LO-2

Providing Cost Information
Managerial accountants must decide:
 what types of managerial accounting information to
provide to managers,
 how to measure such information, and
 when and to whom to communicate the information.
Managers rely on managerial accounting
information that is prepared and provides the best
analysis for the decision at hand.
LO-2

Providing Cost Information (cont.)
There is one major exception.
Managerial accountants must follow specific
external reporting rules (i.e., generally accepted
accounting principles)
 When providing outside parties with cost information
about the amount of ending inventory on the balance
sheet and the cost of goods sold on the income
statement.
 To calculate these two amounts, managerial
accountants must subdivide costs into functional
categories: production and period (i.e., nonproduction).
LO-2

Determining Product Cost
Product (manufacturing) costs are costs, both
direct and indirect, of producing a product in a
manufacturing firm or of acquiring a product in a
merchandising firm and preparing it for sale.
 Only costs in the production section of the value chain
are included in product costs.
LO-2

Determining Product Cost (cont.)
Product costs are inventoried.
Product costs are first added to an inventory
account and remain in inventory until sold, at
which time they are transferred to cost of goods.
Product costs are classified as direct materials,
direct labor, and manufacturing overhead.
LO-2

Direct Materials
Direct materials are materials that are a part of
the final product and can be directly traced to the
goods being produced.
Materials cost can be directly charged to products
because physical observation can be used to
measure the quantity used by each product.
Materials that become part of a product usually
are classified as direct materials.
LO-2

Direct Labor
Direct labor is the labor that can be directly
traced to the goods being produced.
 Physical observation can be used to measure the
amount of labor used to produce a product.
 Those employees who convert direct materials into a
product are classified as direct labor.
A company can also have indirect labor costs.
 Indirect labor is included in overhead and, therefore, is
an indirect cost rather than a direct cost.
LO-2

Manufacturing Overhead
All product costs other than direct materials and
direct labor are considered manufacturing
overhead.
Manufacturing overhead also is known as
factory burden or indirect manufacturing
costs.
Costs are included as manufacturing overhead if
they cannot be traced to the cost object of
interest (e.g., unit of product).
LO-2

Manufacturing Overhead (cont.)
Costs are included as manufacturing overhead if
they cannot be traced to the cost object of
interest (e.g., unit of product).
Manufacturing overhead cost category includes a
variety of items.
 Examples: depreciation on plant buildings and
equipment, janitorial and maintenance labor, plant
supervision, materials handling, power for plant utilities,
and plant property taxes.
LO-2

Calculating Total Product Cost
The total product cost equals the sum of direct
materials, direct labor, and manufacturing
overhead:
Total product post = Direct materials cost +
Direct labor cost + Manufacturing overhead cost
The unit product cost equals total product cost
divided by the number of units produced:
Per-unit Cost = Total Product Cost ÷ Number of
Units Produced
LO-2

Calculating Product Cost in Total
and Per Unit
Cornerstone 2.1

Conversion cost = Direct labor + Manufacturing Overhead
Prime and Conversion Costs
Product costs of direct materials, direct labor, and
manufacturing overhead can be grouped into
prime cost and conversion cost:
 Prime cost is the sum of direct materials cost and direct
labor cost.
Prime cost = Direct materials + Direct labor
 Conversion cost is the sum of direct labor cost and
manufacturing overhead cost.
LO-2

Calculating Prime Cost and
Conversion Cost in Total Per Unit
Cornerstone 2.2
LO-2

LO-2
Calculating Prime Cost and
Conversion Cost in Total Per Unit (cont.)
Cornerstone 2.2

Period Costs
Costs of production are assets that are carried in
inventories until the goods are sold.
Other costs, such as period costs, are not
carried in inventory.
 Period costs are all costs that are not product costs (i.e.,
all areas of the value chain except for production).
LO-2

Period Costs (cont.)
Examples of period costs: Office supplies,
research and development activities, the CEO’s
salary, and advertising.
The level of period costs can be significant and
controlling them may bring greater cost savings
than the same effort exercised in controlling
production costs.
LO-2

Period costs typically are expensed in the period
in which they are incurred.
If a period cost is expected to provide an
economic benefit (i.e., revenues) beyond the next
year, then it is recorded as an asset (i.e.,
capitalized) and allocated to expense through
depreciation throughout its useful life.
LO-2

LO-2

Selling Costs
Those costs necessary to market, distribute, and
service a product or service are selling costs.
Order-
getting
Order-
Filling
EXAMPLES
Warehousing
Shipping
Customer
Service
EXAMPLES
Sales personnel
Salaries &
Commissions
Advertising
LO-2

Administrative Costs
Administrative costs include research,
development, and general administration of the
organization and cannot be assigned to either
selling or production.
General administration ensures that the various
activities of the organization are integrated so that
the overall mission of the firm is realized.
LO-2

Administrative Costs (cont.)
Examples of general administrative costs are
executive salaries, legal fees, printing the
annual report, and general accounting.
Research and development costs are the costs
associated with designing and developing new
products and must be expensed in the period
incurred.
LO-2

Direct and Indirect Period Costs
Distinguishing between direct period costs and
indirect period costs.
Indirect labor is included in overhead.
Service companies: distinguishing between
direct period costs and indirect period costs.
These costs do not affect the calculation of
inventories or COGS for service companies.
Correct classification affects decisions, planning
and control activities for managers.
LO-2

Direct and Indirect Period Costs
EXAMPLE:
Restaurant
Direct Period Cost:
Chef Salary
Indirect Period Cost:
Disposable
Napkins
LO-2

Preparing Income Statements:
Cost of Goods Manufactured
The cost of goods manufactured represents
the total product cost of goods completed during
the current period and transferred to finished
goods inventory.
The cost of direct materials used in production
can be derived using the following formula:
LO-3

Preparing Income Statements:
Cost of Goods Manufactured (cont.)
The direct materials is then used to calculate the
cost of goods manufactured as follows:
+ Direct materials
+ Direct labor
+ Manufacturing overhead costs
+ Beginning WIP inventory
- Ending WIP inventory
= Cost of goods manufactured
LO-3

LO-3
Calculating Direct Materials Used in
Production
Cornerstone 2.3

Work-in-Process
Once the direct materials are calculated, the
direct labor and manufacturing overhead for the
period are added to get the total manufacturing
cost for the period.
The second type of inventory—work in process
(WIP) is the cost of the partially completed goods
that are still on the factory floor at the end of a
time period.
LO-3

Work-in-Process (cont.)
 WIP units have been started, but not finished; they
have some value, but not as much as they will
when they are completed; and there are beginning
and ending inventories of WIP.
 We must adjust the total manufacturing cost for the
time period for the inventories of WIP.
 When that is done, we will have the total cost of the
goods that were completed and transferred from
work-in-process inventory to finished goods
inventory during the time period.
LO-3

LO-3
Calculating Cost of Goods
Manufactured
Cornerstone 2.4

LO-3
Calculating Cost of Goods
Manufactured (cont.)
Cornerstone 2.4

Cost of Goods Sold
To meet external reporting requirements, costs
must be classified into three categories:
 Production
 Selling
 Administration
LO-3

Cost of Goods Sold (cont.)
Cost of goods sold represents the cost of goods
that were sold during the period and then
transferred from finished goods inventory on the
balance sheet to cost of goods sold on the
income statement (i.e., as an inventory expense).
Cost of goods sold is calculated as:
+ Beginning finished goods inventory
+ Cost of goods manufactured
- Ending finished goods inventory
= Cost of goods sold LO-3

Calculating Cost of Goods Sold
Cornerstone 2.5

Calculating Cost of Goods Sold
(cont.)
Cornerstone 2.5

Relationship Between Flow of Costs,
Inventories, and Cost of Goods Sold
LO-3

Income Statement:
Manufacturing Firm
It is important that all sales revenue and
expenses attached to a time period appear on the
income statement.
In the following Cornerstone example 2.6, notice
that the heading of the financial statement tells us
what type of statement it is – Income Statement;
for what firm- BlueDenim Company; and for what
period of time- For the Month of May.
LO-3

Income Statement:
Manufacturing Firm (cont.)
Also note that in the income statement, expenses
are separated into three categories: production
(cost of goods sold), selling, and administrative.
Sales revenue is calculated as:
Sales revenue = Price x Units sold
LO-3

LO-3
Preparing an Income Statement
for a Manufacturing Firm
Cornerstone 2.6

Income Statement:
Manufacturing Firm
Gross margin is the difference between sales
revenue and cost of goods sold:
Sales Revenue
– Cost of Goods Sold
= Gross Margin
It shows how much the firm is making over and
above the cost of the units sold.
LO-3

Income Statement:
Manufacturing Firm (cont.)
Gross margin does not equal operating income
or profit as it is computed without subtracting
selling and administrative expenses.
If gross margin is positive, the firm is charging
prices that cover the product cost.
LO-3

Gross Margin Percentage
A company can compare gross margin
percentage with the average for its industry to
see if its experience is within the ballpark range
for other firms in the industry.
Gross margin percentage varies significantly by
industry.
Gross margin percentage is calculated as:
Gross Margin Percentage
= Gross Margin ÷ Sales Revenue
LO-3

LO-3
Calculating the Percentage of Sales
Revenue for Each Line: Income Statement
Cornerstone 2.7

Operating Income
As you saw in Cornerstone 2.7, selling and
administrative expenses for the period are
subtracted from gross margin to arrive at
operating income.
Operating income = Gross margin - Selling
and administrative expenses
Operating income is the key figure from the
income statement; it is profit, and shows how
much the owners are actually earning from the
company.
LO-3

Income Statement: Service Firm
In a service organization, there is no product to
purchase, like in a merchandising or
manufacturing operation.
There are no beginning or ending inventories and
no cost of goods sold and gross margin on the
income statement.
The cost of providing services appears along with
the other operating expenses of the company.
LO-3

LO-3
Preparing and Income Statement for
a Service Organization
Cornerstone 2.8

Chapter 2: Basic Managerial Accounting Concepts.pptx

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